SEC (Wisely) Focuses On Transfer Agents

Enforcement investigations into microcap, or penny, stocks are difficult and often thankless. They frequently involve unsavory characters who could as easily be running a real estate scam or Nigerian advance fee fraud as one involving securities. Proving intent to defraud in cases like this is often very tough, as the players shield their activities behind foils that make it hard to determine who exactly is saying what to the investing public. 

Make no mistake, microcap stocks are securities, and the Securities and Exchange Commission is responsible to police the markets for them. But as a civil agency, the SEC comes to these investigations with a somewhat weak hand. It isn’t going to put anyone in jail. At the end of the day it can seek injunctive relief and civil penalties against defendants, but those remedies pale in comparison to the prospect of time behind bars. For people who aren’t interested in participating in the legitimate financial system and don’t especially care about an injunction prohibiting them from violating the law again, a court order seems like a pretty thin threat.

Also, taking such cases to trial is expensive and quickly puts the lie to the notion that the federal government operates with unlimited resources. Every day spent on proving the bad intent of a penny stock fraudster is a day not spent on another case that is potentially more damaging to investors. 

All of which is why this case should be encouraging for those who hope for a strong SEC to police the capital markets. Here, the Commission brought a recordkeeping action against a transfer agent that appears to have fallen woefully behind in its obligations to maintain accurate records of the securities with which it was entrusted. Many corporate issuers of penny stocks use independent transfer agents such as National Stock Transfer, the corporate defendant at issue here, to maintain records of investors and account balances and transactions, to cancel and issue stock certificates, to process investor mailings and to deal with associated problems. If they’re not keeping accurate records, pretty much the transfer agents’ only job, something has gone badly wrong. But some of them don’t. And if the records are bad, one can be pretty sure that their issuer clients are not terribly interested in accurate information being conveyed to their investors.

The SEC’s decision to focus on a gatekeeper like National Stock Transfer, instead of trying to prove fraud by the many underlying issuers, is a smart one. Bad recordkeeping is like a gateway drug in the securities world. It almost certainly portends other bad activity, and cutting off access to irresponsible gatekeepers by suing them for non-scienter-based violations is an intelligent way for the SEC to save resources for bigger issues.